scorecardresearchNecessary financial aspects for consideration before investing in stocks

Necessary financial aspects for consideration before investing in stocks

Updated: 18 Feb 2022, 02:34 PM IST

Having money to invest in stocks is not enough. Check for important factors before putting money in shares.

Initial Public Offering (IPO) is the process of conversion of a privately held firm into a public firm by trading its shares.

Initial Public Offering (IPO) is the process of conversion of a privately held firm into a public firm by trading its shares.

Investing in stocks may look cool, but not always profitable unless you know what you are getting into. If you have a long-term vision, parking money in the share market can be a great way to earn profits. How to analyze a company is crucial while deciding which stocks to include in your investment portfolio. Instead of going with the flow, it would be worthwhile for you to check the following financial aspects before deciding to buy the shares of a particular company. 

The extent of liquidity

The proportion of liquid assets to the fixed assets of a company matters if you want to check the liquidity position of a company. Some companies have highly liquid assets, which means that they can be sold for their full worth sans any hassle. Check for both market liquidity and accounting liquidity. The former refers to the ease with which you can trade a company’s stocks in the market, whereas the latter refers to the company’s ability to meet its short-term liquid requirements.

Debt to Equity ratio

A company’s ability to repay its debt matters. The proportion of debt to equity underscores a company’s overall financial health. A higher debt-to-equity ratio indicates how it might be difficult for the firm to obtain funding when needed. Too much debt can push a company into facing irreparable losses in the long run. Also, a high debt-to-equity ratio means that a company borrows cash heavily from the market to meet its operational needs, whereas this ratio on the lower side implies that the company uses its assets wisely to borrow less from the market.

A diversified portfolio neatly divides your assets into more than one asset class in order to reduce risk and maximize profits.

Net profit margin

This financial concept helps to find out how much profit a firm makes to its total revenue. You can calculate the net profit margin by dividing the net profit by the company’s sales and expressing the same in percentage. The net profit is calculated by subtracting the company’s total costs from its total revenues earned. This net profit when divided by the company’s total revenue yields a percentage that must be high for its shares to be considered for trade.

Return on Equity (ROE)

This is the ratio of a company’s net income to the equity held by its shareholders. This may also be evaluated by dividing the company’s dividend growth rate by its profits retention rate. You can assess two facts easily by looking at this ratio. One, you can gauge the health of your income statement and balance sheet. Second, you can check for the net income or profit compared to the shareholders’ equity. A higher ROE implies the ability of the company to transform equity investments into profits.

Price to book value (P/BV)

This aspect is rarely considered except while assessing companies that are highly liquid including banks or financial institutions. The company’s market price is its value according to the stock market. The book value is the amount that will remain if the company liquidates all its assets and pays off all its liabilities. This ratio is used to value the shares of companies with large tangible assets on their balance sheets. A P/BV ratio less than 1 means that the stock is undervalued as the assets in the company’s books hold more weight and value to the value assigned by the market, thus, highlighting its inherent value.

Promoters’ holdings

The quality at the helm matters and that is why you must be aware of the management and promoters of the company whose shares you want to put your money in. The horse pulls the cart and not otherwise, which means that the efficacy of a company’s management and the integrity of its promoters can further a company’s revenues while enhancing its profits and value in the long run. Also, interested shareholders must take note of the company’s holdings, especially, how this ownership pattern changes with time with an increase or decrease in the promoters’ shareholdings. You must track changes in the promoters’ holdings in the past five years before deciding to invest in that stock.

First Published: 18 Feb 2022, 02:34 PM IST